Why the SBA Should Be Abolished

The Small Business Administration is without a full-time administrator, but the President shouldn’t bother putting a short list together.

It’s high time to eliminate the SBA altogether.

Rarely has an agency had less impact on the group it purports to benefit than the SBA. With lax underwriting standards, high default rates and a lack of results, the SBA has become a non-entity in the small-business world and a risk to taxpayers.

Here's why:

It funds bad ideas.
The SBA’s loan programs are designed to fund businesses that can’t find funding elsewhere. That’s seen as a noble role – one worthy of taxpayer dollars. It is also insanely risky. The financial markets are eager to back companies. Private equity and venture capital firms raise billions of dollars to put to work funding innovative ideas. Banks are eager to lend to local businesses. Many corporations invest in smaller companies for strategic and competitive reasons. Thanks to record-low interest rates, there is no shortage of capital to put to work – only a shortage of good ideas.

And that’s sadly where the SBA has carved out its niche. Once companies find the funding doors closed to them everywhere else, they turn to the government.

But, should these companies even be funded in the first place? While a private-equity firm has fairly strict criteria for the companies they back, the rules for who qualifies for a loan, the SBA has relatively loose criteria, particularly for its smallest loans. Underwriting is done by banks, but, with the SBA assuming much of the risks for these loans, many banks will offer SBA-backed loans for businesses that wouldn’t otherwise qualify for private market loans. As a result, it lets through ideas that the marketplace has already determined won’t fly. That’s a waste of capital that could be deployed elsewhere.

It subsidizes banks.
There’s a myth that the biggest financial benefit the SBA produces is for small businesses. Rather, the real wealth accrues to the big banks. The SBA’s primary 7(a) lending program guarantees 85 percent of loans up to $150,000 and 75 percent of those from $150,000 to $5 million. The banks issue the loans knowing they can’t lose. If the borrower defaults, the banks get much of their money back from the government.

Is it any wonder, then, that large banks love the program? According to Cato Institute analyst Tad DeHaven, there were 2,600 eligible lenders under the SBA’s 7(a) program, but the top 10 made up for a full quarter of total volume. “Although lawmakers portray the SBA’s loan programs as a boost for small businesses, the programs are actually a form of corporate welfare for some of America’s largest banks,” DeHaven wrote.

It has a horrendous track record.
Since banks have a guarantee that they won't lose money, there are little real underwriting standards. A damning report in the Dayton Daily News this year found that, since the beginning of 1990, 168,324 bad loans were completely charged off to the Treasury, representing $8.6 billion in payments to lenders by the SBA.

Further data suggested many of these borrowers should never have gotten the money in the first place. More than half of the 168,324 charged-off loans failed before 20 percent of the loan was repaid. More than 1 in 3 repaid only 10 percent or less of the loan. More than 7 percent did not reduce the principal on their loan at all, according to the Dayton Daily News.

It puts taxpayers at risk.
So, if the banks aren’t facing any risk, who is? You are. The total taxpayer cost for these failures, according to the Dayton Daily News, is $1.3 billion. And that's on top of all the other overruns at the agency. In fact, the SBA has a poor track record when it comes to spending within its means. Between 2006 and 2011, the total excess spending vs. what the SBA requested in funding grew from $100 million to $5 billion. And SBA's actual spending in that period has grown more than 600 percent, from $905 million to $6.2 billion, according to Veronique de Rugy, senior research fellow at the Mercatus Center at George Mason University.

It’s not as important as you think.
Of the top 15 industries receiving the most SBA-guaranteed loans over the past 10 years, only 0.5 percent of the small businesses in these industries received loans backed by the SBA, de Rugy, a longtime critic of the SBA, says. In short, large businesses, in industries that matter most, get only a negligible amount of funding from SBA-backed loans. That means shutting down the program would have a negligible effect on lending. Why keep a government agency in place if most of the market wouldn't notice it is gone?

There are better alternatives.
When the SBA was established in the 1950s, there were few places a business could go to fund its growth. That's not true anymore. Innovation has come to financing. Just look at the crowdfunding boom. Last year, 308 crowdfunding platforms across the world raised $2.7 billion, an 81 percent increase over the amount raised in 2011, according to research firm Massolution. The growth in 2012 represents an acceleration, up from 64 percent growth in 2011. Looking ahead, growth is expected to reach $5.1 billion raised in 2013, representing an expected 89 percent increase in the dollars raised, Massolution said.

Ideally, the SBA could defend itself from calls for it to shut its doors by citing its track record of helping to build and sustain new businesses. But it can't, because it doesn't track its own performance. Not only that, it can't even prove its raison d'être: that it needs to exist to help businesses shut out of the markets.

“Unfortunately, the SBA doesn't attempt to measure the effectiveness of its loans,” de Rugy has said. “If it did, it would have to confront a large body of research that refutes the belief that credit rationing makes it difficult for small businesses to obtain capital.”

So the country can live without the SBA. Perhaps there was a time when the SBA served a purpose for businesses. With abundant capital, better private-sector options and more worthy budget priorities for the government, now is no longer that time.